Banking on union

The European Commission will present its blueprint for a body to refloat or fold troubled banks, largely in the euro zone. As we’ve said ad nauseam, there is no chance of a great leap forward on this front ahead of Germany’s September elections. The question is whether Berlin’s line softens thereafter.

Brussels will suggest a cross-border body able to overrule national authorities. Germany is opposed and says that would require treaty change which could take many years. Beyond that the EU’s executive appears to have pulled its punches somewhat.

The new authority will have to wait years before it has a fund to pay for the costs of any bank closures since the plan foresees a levy on banks to build a war chest of up to 70 billion euros which is expected to take a decade, leaving the agency dependent on national schemes for years.

The EU’s executive will also not call for the euro zone’s rescue fund, the European Stability Mechanism, to act as a backstop in the meantime, undermining a central goal of banking union – to break the “doom loop” where indebted governments have been forced to bail out stricken banks which in turn have loaded up on that government’s debt, pushing both into a downward spiral.

Key ECB policymaker Joerg Asmussen said yesterday that a “resolution fund” should be financed by levies on the whole banking sector and with a European government backstop, delinked from national budgets. Germany fears it will be left with the bill for failed banks in other euro zone states if that happens.

Without a mechanism to wind-up or restructure failing banks, with pooled risk, the euro zone crisis cannot be declared over and the seeds of a future blow-up may have been sown. Asmussen, who will be speaking again later today, said he didn’t expect a sea change in Berlin after the elections and noted that several other countries shared its concerns. For its part, the ECB is likely to take over its supervisory role late next year. It does not want to be exposed without parallel structures in place.

Italy will sell a whopping 9.5 billion euros of short-term treasury bills but despite the turbulence caused by the Federal Reserve’s exit plan – and subsequent rise in euro zone borrowing costs – primary market issuance still appears to pose no problems. Spain sold a 15-year bond via syndication on Tuesday and met strong international demand, allowing it to shift 3.5 billion euros-worth.

However, in Italy’s case, a ratings cut by S&P last night, with the threat of more to come, could cause a few jitters. Rome said S&P’s analysis was backward looking but the ratings agency’s forecast of a deeper economic downturn this year – with the pressure that will put on the deficit – is in line with the IMF and most other forecasters.

With the government at odds over issues ranging from demands to cut an unpopular housing tax (although there are suggestions a deal could be imminent on this) to an order for F-35 combat jets and the legal problems of centre-right leader Silvio Berlusconi, prospects of concerted political support for reform appear weak.

Italian government bond futures have fallen by about half a point in response to the downgrade and safe haven German Bund futures have climbed a little. European stock futures are also pointing south after unexpectedly weak Chinese trade data.

Portugal’s new government set up is yet to be sanctioned by the president but already Paulo Portas, the man promoted to deputy head of the government and given the task of liaising with the countries EU/IMF lenders (who return for a review next week), has declared that what is needed is a “cycle that boosts the economy, companies, job creation and social cohesion”.

Portas, who resigned as foreign minister last week a day after the finance minister did the same but was then brought back into the fold to avoid the government collapsing, is a known critic of austerity. How the EU and IMF react remains to be seen.

Unlike Athens, Portugal is viewed as having tried to do the right thing (at the price of pushing the country deep into recession) but even so the lenders will not want to see an end to the austerity and reform programme. Then there is the fact that Portas resigned ostensibly over Prime Minister Pedro Passos Coelho’s pick as the new finance minister, so there would appear to be no love lost there.

Portugal may well fail to exit its bailout as planned next year and will require further help. Greece’s situation looks more parlous still.

We got hold of the troika’s report yesterday which showed a high degree of alarm on the part of the EU and IMF. The report showed Athens could face a fiscal gap of up to half a percent of GDP – 2 billion euros – this year and next if it fails to deliver on the reforms its backers demand in return for fresh bailout cash.

For 2015 it predicts a fiscal gap of more than 1-3/4 percent of GDP. All that adds up to the likelihood of a fresh debt writedown being required which this time will hit euro zone taxpayers since the bulk of Greek government bonds are held by euro governments.

The lenders might trust the Portuguese government to stay the course so far. They appear to be much less certain about Athens.